Does the crisis protect us from creating another bubble?

bubblesLast month, President Obama warned that “[w]hen wealth concentrates at the very top, it can inflate unstable bubbles that threaten the economy.” On August 10, he further cautioned that even in a slow-growth environment, we have to avoid the creation of “artificial bubbles.”

These warnings come after a prolonged period of historically low interest rates and the Federal Reserve’s unprecedented Quantitative Easing (QE) program. Although recent talk of tapering has sent bond yields up, the program has seen the central bank increase its balance sheet from $900 billion before the collapse of Lehman Brothers to $3.6 trillion. The S&P 500 index is chasing new highs and is up over 240% since its lowest point during the crisis, despite slow growth in the economy. Even Ben Bernanke hinted that low interest rates may incentivize risk-taking by financial institutions.

In this environment, fears about new bubbles are widespread. Some claim that—following an unhealthy pattern of artificial recoveries since the tech-bubble of the 1990s—the driving forces of the current recovery are again real estate and automobile sales. As these are mostly debt-financed, the argument goes, the recovery is fuelled by cheap credit and far from being structural. It is true that house prices have seen an impressive recovery, rising 15% year-on-year in June. Similarly, one can find a very high correlation between car sales and economy-wide growth figures. However, correlation does not imply causation. After 5 years of deleveraging, job uncertainty, and a significant reduction in net household wealth, it seems likely that buyers would postpone important investment decisions. The recovery in housing and automobile markets is therefore also a consequence of increased consumer confidence that results from an improved economic outlook, something that can be seen as a positive sign.

Others see bubbles in gold, investment in China, in emerging markets generally (though this risk might have been reduced after important capital outflows following the Fed’s announcement of tapering), treasuries, college tuition, and exchange-traded funds (ETFs). Another interesting example is the so-called “carbon bubble,” according to which oil-exploring firms do not factor in the possibility of government action on climate change, which could see two-thirds of fossil fuel reserves remain buried. Most convincing, along with Ben Bernanke’s concerns, is the argument that looks at the structural impact of central bank policy on the economy: while large corporations have access to cheap credit that boosts their profits and sends their share prices up; small firms cannot obtain loans at all, and sorely needed investment is postponed.

But does the current rise in stock prices really indicate a growing bubble? After the 2008 crisis, everyone can tell the tale: it all started with the housing bubble that turned into the subprime-mortgage crisis as loans turned sour. Because the financial sector was then forced to curtail lending, the global economy was pushed into a recession, which turned into a sovereign debt crisis in Europe as tax revenues declined and exposed structural imbalances that had been hidden by the bubble.

In hindsight, this is an easy story to tell, but people know little about what creates bubbles in the first place, and—more importantly—what drives investors to make such seemingly irrational decisions when, ex post, it is so easy to identify a “bubble”. As Harold L. Vogel writes, financial asset bubbles are broadly seen as inflations of price beyond what would be expected based on fundamental economic features alone. However, it is very difficult to identify what prices these fundamental features give rise to.

Economic research has produced many theories about the emergence of bubbles but so far, no model has been found to describe—or even predict—patterns of financial bubbles. Among the most debated issues are the assumptions of efficient markets and the rationality of actors. Although it might be rational for single investors to participate in bubbles when they expect others to remain in the market, Vogel rightly points out that the very idea of a bubble requires that there is a wave of irrationality that carries a majority of investment decisions in the excitement of the moment.

Several explanations for this irrationality have been investigated, and behavioral economics will have much to contribute to the debate over the coming decades. At the heart of the creation of a bubble seems to lay a tendency of humans to linearly extrapolate from past performance. Neurological research suggests that investors even override more cautious instincts to sell at times when they fear markets might crash. Furthermore, dynamic prospect theory posits that people change their very attitude to risks over time. The more they have already gained, the less risk-averse they become—implying a strong departure from rationality.

Overall, academic research suggests that a (limited) departure from the investor rationality and efficient markets hypothesis is warranted. Under conventional assumptions, statistical theory would suggest that daily market return amplitudes of 4% would only be observed once every 63 years (but it has been observed on several days in 2008). Clearly, markets do not always behave rationally.

The question that naturally follows is whether this is necessarily bad. Some claim that bubbles might actually spur much-needed technological investment that can drive future growth. Furthermore, bubbles might just be part of the economic cycle of boom and bust. After all, household wealth took a $5 trillion hit with the implosion of stocks in the 1990s, without causing anything like the current crisis.

But this does not square with the common narrative of the post-2008 financial crisis. Paul Krugman has argued that what makes this time different is the concentration of risk in the financial sector. The reason the burst of the bubble caused so much damage to the economy was that banks had to repair their balance sheets and therefore curtailed lending, which caused the economy to contract and the governments to bail out banks in order to prevent further damage. More worryingly, these bail-outs came with few strings attached, so that banks have no incentives to avoid similar behavior in the future.

Is this what we are witnessing right now? By historical standards, price-to-earnings ratios are normal, but some analysts claim that these are unsustainable because profits are held artificially high by low borrowing costs. While the profit-to-GDP ratio has historically been at 6%, it is currently at 10%, and Smithers & Company, a London-based market-research firm estimates stocks are overvalued by forty to fifty per cent compared to historic values. Counterarguments cite lower taxes, globalization (profit-to-GDP ratios are inadequate as companies make much of their profit abroad), and high unemployment (that allows companies to cut payrolls) as reasons for the relative surge in profits.

It comes in the nature of a bubble that it is quite difficult to realize when one is in it. Prolonged periods of low interest rates and QE certainly bear the danger of providing excess liquidity to financial speculators. With sluggish growth, investors are sitting on large piles of cash and seek returns, which can prepare an irrational environment prone to the development of bubbles. Although the stock markets are high, the money supply remains low, and there does not seem to be the same sense of euphoria that we have seen during earlier bubbles. Furthermore, one has to remember that central bank policies often follow a Taylor rule of monetary policy, which is highly dependent on economic performance—low interest rates therefore indicate, above all, bad economic performance. For the moment, the danger of a financial bubble does not seem to be imminent, but both the President and the Chairman of the Federal Reserve are right to keep an eye on financial markets as the economy gathers pace.

Posted by: Marvin Gouraud

Sources: Harold L. Vogel (2010) “Financial Market Bubbles and Crashes”, Bloomberg, U.S. Census, Financial Times, Forbes, Wired, Huffington Post, The New York Times, The Guardian, The New Yorker, NBC News, Leir Center for Bubble Research, The Telegraph, CNN Money, The Economist, IMF, Federal Reserve,

Photo credit courtesy of Maricel Cruz (edited)


Bitcoin and the Challenges of Virtual Currency

bitcoinAlthough Bitcoin, the “world’s first decentralized digital currency”, was launched in 2009, it has only recently gained popularity as a currency. Unlike other existing currencies, Bitcoin lacks a central monetary authority, which creates problems for financial regulators. In place of a traditional central monetary authority, a computer network composed of Bitcoin users self-regulates the currency. Members of this Bitcoin network “monitor and verify” the creation of new Bitcoins and also regulate transactions between users.

Bitcoins are generated through a virtual process known as “mining.” A unique serial number is allocated to each Bitcoin after it is created. However, the total number of Bitcoins that can be produced is limited to 21 million. There are currently about 11 million Bitcoins in circulation, equivalent to approximately $1.2 billion. Popularity of the Bitcoin currency has recently surged, as Bitcoins have recently become available to “ordinary customers and businesses.” Many small businesses are therefore beginning to accept Bitcoin as a viable form of payment. Small businesses in particular benefit from Bitcoin’s swipe fees, which are on average about 2% lower than those of credit cards. Owners of small businesses also favor the simplicity of using a virtual currency as opposed to cash or other forms of payment.

Various complications have emerged as authorities attempt to regulate Bitcoin’s use as a currency. Because Bitcoin users can maintain anonymity in transactions, Bitcoins are likely to be used for illicit purchases or transactions. As a result, federal and state regulators “are taking steps to prevent people and companies from using them for illegal activities.” In a recent interview, Benjamin Lawsky, superintendent of New York’s Department of Financial Services, stated, “Virtual currency firms inhabit an evolving and sometimes murky corner of the financial world.” However, authorities must gain a deeper understanding of Bitcoin’s mechanics before instituting effective regulatory measures. As Tony Gallippi, CEO of Bitcoin-handling company BitPay, explained, “You can’t apply the rules for the horse and buggy to an automobile.”

Bitcoin has recently faced a stream of legal difficulties. Last week, two prominent officials of the Bitcoin Foundation travelled to Washington to meet with federal officials, attempting to prove their willingness work within federal laws. General council of Bitcoin, Patrick Murck, told officials, “There’s a myth about Bitcoin that it is an anonymous payment network. That is not true. [Bitcoin has] an open public ledger that shows every transaction.” Although Bitcoin’s ledger is public, there is no formal mechanism to tie Bitcoin addresses to the identities of their owners. It is also unlikely that Bitcoin will mandate user identification in the future, as this would alter the configuration that made it successful in the first place.

So far, Bitcoin has lacked stability as a currency and many argue that Bitcoin is losing steam. In January 2013, Bitcoins were worth $13, rising to $266 by April, and falling to about $100 today. Due to the general novelty of online currency, Bitcoin’s future remains uncertain. Perhaps with tighter regulations and less volatility, Bitcoin and other virtual currencies will gain prominence in the global market.

By: Marjorie Baker

Sources: Wall Street Journal, Economist, Economic Times, NBC News, Washington Post

Photo Credit: Bitcoin courtesy of flickr user Electric-Eye

World Economic Forum 2013: A Post Crisis Davos

WEFAs the global economy begins to show signs of recovery, leading economic thinkers, heads of states, and major CEOs recently met in Davos, Switzerland for the annual World Economic Forum. These VIPs attended numerous events, networked, and traversed a new global economic landscape characterized by renewed optimism. The new disposition was reflected by this year’s theme—“resilient dynamism”—which represents an important shift in the perception of the world economy from something that is weathered to a force that can provide new opportunities.

While the outlook has become more hopeful, it does not mean that we are out of the woods just yet. As Axel A. Weber, Chairman of the Board of Directors of UBS, Switzerland, and a Meeting Co-Chair, declared, “The feeling is that the worst is behind us. But the mood bordered on complacency.” Not everything pointed towards the positive, especially the WEF’s own Global Risks 2013 report which offers a pessimistic outlook, saying the global community’s ability to address significant challenges, such as global warming, were limited by economic issues like “severe income disparity” and “chronic fiscal imbalances.” The report concludes that these systemic problems must be addressed in the near future in order to both sustain global economic growth and to avoid widespread social unrest.

On an interesting side note, the WEF, working with the science magazine Nature, noted several important but relatively remote potential economic threats known collectively as “X Risk Factors.” These include: Runaway Climate Change, Significant Cognitive Enhancement, Rogue Deployment of Geoengineering, Costs of Living Longer, and Discovery of Alien Life. While these issues are currently not as tangible as “concerns such as failed states, extreme weather events, famine, macroeconomic instability or armed conflict,” says the WEF, “they capture broad and vaguely understood issues that could be hatching grounds for potential future risks.” However, it is not unimaginable that we may confront many of these issues in the coming decades, and therefore, it is prudent to prepare for these prospective threats.

Overall, while Davos may often be thought of merely as a gathering of “fat cats in the snow,” it does have real worth both through its influence in setting the economic discourse and its role as a place for global leaders to reflect on global economic challenges.

Posted by: Matthew Goldberg

Sources: WEF, CNN, Business Insider, The Information Daily

Photo Credit: World Economic Forum 2013: Microphones courtesy of flickr user World Economic Forum

Is Having the Right Skills Enough to Get Hired in Post-Recession America?

skills gapOne of the most common explanations for the persistent high unemployment in America since the 2007 recession is the skills gap. An Accenture report estimates that, “about a third of employers worldwide are experiencing critical challenges filling positions due to a lack of available talent, and almost three-fourths of employers are affected by talent shortages to some degree”.  Technology and globalization processes have increased the demand for talented and high-skilled workers, and many say that the nation’s education institutions have not risen to meet the challenge effectively.

The Brookings Institute issued a report that includes eleven “new learning skills in the 21st century” that are crucial for our students. These include: simulation, multitasking, and distributed cognition (effectively utilizing tools that enhance mental capacity). Meanwhile, the Center for 21st Century Skills advocates six different skills: information literacy, creativity & innovation, collaboration, problem solving, communication, and responsible citizenship. Proponents of the skills gap view see unemployment as structural, a product of supply falling behind demand in the skilled labor market. A recent Wilson Center publication by Paul Vallas argues that the skills gap “poses a major threat to the United States’ long-term economic competitiveness”. The American education system is falling further behind the performance of other countries, and addressing the “massive achievement gap present within the U.S. between minority and socio-economically disadvantaged students and their more affluent peers” should be a national priority.

However, many disagree with this assessment of a skills gap as the main cause of high US unemployment, and propose a demand-side rebuttal that focuses on the drop in real household wealth associated with the recent recession. This has decreased household demand nationwide and thus crippled job growth. Research done by the Economic Policy Institute  argues that persistent unemployment at all levels of education, and in most major sectors of the economy indicates that the current high rates of unemployment are caused by more than just a skills gap. They also attribute the rise in educated labor as a percentage of the total labor force to the rapid growth in sectors that demand high-skilled labor. Other research  at the Economic Policy Institute points to record corporate profits in the past year, saying that businesses learned during the recession how to make money with lower labor costs, and now don’t need to hire as many people to make higher rates of profit. Some of this can be explained by the fact that traditionally labor intensive industries have been the hardest hit by the recession, while high-tech companies with lower labor demands have seen the most growth.

To create policy that will improve the state of the economy, it is important to understand the causal linkages for the unemployment problem in America. . For example, structural unemployment cannot be solved with demand-side economics such as stimulus packages. On the other side, education initiatives and on the job training is the answer to a skills gap.

Posted by: Ben Copper

Sources: Accenture, Brookings Institute, Economic Policy Institute, CNNMoney, Commerce Department

Photo Credit: flickr user, Dita Margarita

Techonomy Conference 2012: Objectives of Technology-Driven Economic Revitalization

On Wednesday, September 12th business leaders, political figures, and technology experts came together for the annual Techonomy Conference in Detroit. Hosted by the Detroit Economic Club, the conference’s agenda focused on the role of technology as a vital component of achieving social progress and economic growth.  This single day program is especially committed to the issues of “reigniting U.S. competitiveness and economic growth, creating jobs, and revitalizing cities in a technologized age”. Featured speakers included Grady Burnett, the Vice President of Facebook’s Global Market Solutions, James Dougherty, an Adjunct Senior Fellow for Business and Foreign Policy on the Council of Foreign Relations, and Justin Fox, the Editorial Director of the Harvard Business Review. They addressed the crowd on topics ranging from challenges in the era of globalization to the democratization of finance and product development to the future of manufacturing and its impact on employment. Audience members were also greeted by the founder of Techonomy, David Kirkpatrick, and treated to speeches on individual entrepreneurial development and other related topics.

The conference took a local look at Michigan and Detroit’s economic struggles for revitalization and at the challenges faced auto-mobile industry. Described as the Silicon Valley of an “earlier era”, Detroit is said to represent the larger issues facing American cities, including adapting to changes in education, employment, and infrastructure brought on by an increasingly globalized market society. Some have questioned the conference’s location of Detroit due to current economic struggles. Techonomy’s founder sends a different message, citing Detroit’s troubles as emblematic of cities that have missed the opportunities of technology in the past but have the potential to resolve these issues. Even a recently hurting automobile industry, a defining characteristic of Detroit, stands to make substantial gains from strengthening its tech culture of efficiency and educational achievement.

What were the goals and expectations of Techonomy? The event sought to utilize the revitalization of industry through technological advances, entrepreneurship, and innovation as major strategies for economic recovery. A focus on the increasing globalization of business and industry practices seemed also to be an objective of the conference. Intent on keeping America pushing the technological envelope, speakers discussed the future of expanding innovation and inspiring competitive growth. Complementarily, lecturers represented a diverse background of national industry and intellectual leadership, to address the concern of declining US competitiveness in detail and tackle the issue from unique viewpoints.

What can the public expect to come from this meeting of multi-disciplinary minds? Perhaps policy-makers will be influenced by the incredible support from the business community for this technology initiative as a means of creating jobs and stimulating urban development. Another possible outcome is a renewed emphasis on education for current and future generations to establish a more highly-skilled workforce with improved techno-literacy. Finally, perhaps Americans will see more pressure for regulatory reform easing start-up business restrictions. Ultimately, conference publicity should push technology to the forefront of economic recovery initiatives as a tool for improving US competitiveness and improving urgent urban issues to speed along city development.

Forbes highlights examples of innovative entrepreneurs in the Detroit area who exemplify these aims and serve as best-practice models for aspiring start-up companies. With the help of the Techonomy and its conference speakers, the American public may be able to look forward to more success stories like these.

Posted by: Sophia Higgins

Sources: Techonomy, Forbes, CNBC

Photo Credit: 2010_08_05_techonomy_105 @ Techonomy courtesy of Flickr user dserals


Immigration Lessons From Our Northern Neighbor?

True or False: Canada has a higher foreign-born population, per capita, than the United States?  Surprisingly, it’s true and it speaks to the lessons the U.S. might learn on how to integrate immigrants into their economies.

While the United States has long had the image around the world as the refuge of the “tired, poor, and huddled masses yearning”, its increasingly arcane and complex immigration system is coming under fire as inefficient in a global economy where labor, just as much as capital, is flowing freely across borders.  More business leaders and policymakers are arguing that immigrants, especially those with in demand skills, are needed to fuel economic growth.

Canada has already caught on to this trend and is taking advantage of gaps in the American system.  Look no further than, where one of the main links is for foreigners in America on a H1-B or temporary work visa and how they can be fast tracked for Canadian immigration.  Canada, of course offers many of the same things to immigrants the U.S. does: a high standard of living, an advanced economy, rule of law, peace and safety.  In addition, Canada has made a concerted effort to use immigration to directly fill gaps in its labor force, something the US has yet to do.  To determine who is granted a permanent visa, Canada has a simple point system that awards points for things like level of education, occupational skills, language ability, and others factors relevant to productivity.  Only 22% of its immigration was for family reasons (i.e. reuniting mothers with children, brothers with sisters, etc.) while about two thirds of all permanent visas were granted for economic reasons.  In the U.S., the inverse is true: Only 13% of green cards last year were doled out for economic reasons, while two-thirds were for family reunions.

The StartUp Act 2.0, currently being deliberated in both houses of Congress, contains provisions that shift the immigration paradigm in the U.S. towards a more economic view.  The Act would create a new visa for immigrants who graduate from U.S. universities with a master’s degree or doctorate in STEM fields and also create an entrepreneur’s visa to enable immigrants with capital to start businesses and create jobs in the U,S,, rather than returning home to do it.

The U.S. faces both demographic changes (aging and shrinking labor force) and economic forces (e.g. a shortage of STEM workers) that can be solved by a smart immigration policy.  As of now, the US is educating and accepting intelligent and hard-working immigrants temporarily, who are then forced to either return home or go to a country like Canada, where they create jobs and contribute to growth.

Posted by: Sean Norris

Sources: CNN, The Christian Science Monitor, The Fort Wayne Journal-Gazette

Photo Credit: Citizenship Ceremony courtesy of flickr user mars_discovery_district

Reverse Innovation: Create Far From Home, Win Everywhere

Which way does innovation flow? Traditionally, products and services have been thought of as originating in advanced economies, which have a more suitable environment for technological development than do developing countries. Authors Vijay Govindarajan and Chris Trimble would argue that the reverse is also true.

Deputy managing editor of the Wall Street Journal Alan Murray reviewed Govindarajan and Trimble’s new book Reverse Innovation, which provides a different model of successful product innovation. Rather than taking products designed for developed countries’ demands, businesses have increasingly been doing the reverse – creating “innovative new products for developing countries” and adapting them “to satisfy demands in the developed world.” Murray provides several of the authors’ examples of “reverse innovation” in his article, including General Electric’s inexpensive compact ultrasound medical scanners that were originally developed for the Chinese market, but became successful just about everywhere.

However, “reverse innovation” is held back by the low profit margins of the developing world. To combat this obstacle, Govindarajan and Trimble promote “local growth teams,” which Murray describes as “small, cross-functional, entrepreneurial groups located in emerging markets” that can both effectively utilize advanced technologies and cater to local markets.

Indeed, finding a way to mitigate these barriers to innovation could greatly help developed countries address significant problems such as rising health care costs. Reverse Innocation authors use the example of Narayana Hrudayalaya hospital in India, which had benefited from “process innovation” – the key to lowering the cost of open-heart surgery to around $2000, about a tenth of what it costs in the U.S.


Posted by: Pokyee Yu

Sources: The Wall Street Journal, Reverse Innovation

Photo Credit: Reverse Innovation. By Vijay Govindarajan and Chris Trimble. 229 pages. Harvard Business Review Press. $30